One of the most frequent stats on founders’ slides we get to see is how much damage errors and rework are causing. These errors create a ton of claims and disputes in construction.

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‘The degree of efficiency in an industry can be judged by checking its disputes.’

— Feodor Dostoyevsky, paraphrased

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I recently realized that disputes are an interesting symptom of inefficiency in an industry. There are some industries that most people would call well-professionalized — for example automotive or aerospace — and where errors and disputes are under control.

After 2 years investing in tech companies in this space I can say: Construction is not one of those industries.

Here are my 10 slices on disputes in construction:

1/ The average dispute value on construction projects is around 8% of the project’s value. The average dispute then settles for around 2% of the value.

2/ And: for projects where the winning bid is 20+% lower than other bids, 70% of those projects have disputes.

3/ And: In North America, the main cause of dispute in 2018 was ‘errors or omissions in the contract document‘.

4/ But: Projects where the general contractor has a subjectively high expectation of future work with the same client, the rate of dispute drops to below 10%.

5/ Ergo: Contractors win contracts by underbidding. And: they claim 4x more than they settle for. When they are confident they win the next bid, they stop underbidding and stop claiming.

6/ Ergo: Incentives matter. A lot. Negotiation doesn’t stop with the contract — it carries on. The first incentive is winning the first bid. And then contractors want to win the next bid, ideally at a larger volume and better margin. Hardly a surprise for anyone who understands behavioral economics. But: at this scale incentives are out of control in construction.

7/ And: Transparency and objectivity matter. Getting away with a too low bid might not have been invented by the construction industry (defense industry, anyone?) but the EPC players might have perfected it. Opacity and un-objectivity result when speed or quality either (1) are subjective — which is fundamentally NOT the case in construction — or (2) are objective but cannot be measured objectively or (3) conditions or requirements change versus the initial agreement. What we see is this:

Building code eliminates subjectivity in most mature markets;

The ability to measure in construction appears low. However: It takes a lot of work to do it in a high resolution and in almost real-time. Technology, to date, has not been on a level to monitor actual execution efficiently. This is changing dramatically;

Changing conditions and requirements are a major source of opacity and subjectivity.

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8/ Ergo: Disputes happen because contractors have incentives to win projects, and because they get away with under-bidding or under-performing as under-performance can be easily attributed to changing conditions rather than execution. With increasing resolution of measuring project execution, transparency and objectivity increase dramatically. In turn, they improve an owners/developers ability to judge speed and quality within a project and across projects.

9/ Question mark we haven’t figured out yet: In 2018, the average dispute value was $57 million in Middle East markets, with an average time to settlement of 20 months. In North America, $16 million (= 28%) and 15 months. Possibly a result of different project values, but maybe other contributing factors such as code, competition and business practices as well?

10/ Founder opportunities: We would like to see more founders/companies systematically addressing the following angles:

Efficient real-time objectivity — the challenge is not providing objective data in real-time. The challenge is collecting objective data in real-time, without delay. We see a lot of companies collecting data on site where the action is — we see yet too few companies systematically collecting data in what we call the “dark corners” of construction, eg. in payments/transactions, in trucks, and in ready mix plants and in timber plants. Think about collecting real-time data in those dark corners.

Smart incentives (before you shout smart contracts and blockchain — you can do that more easily. It doesn’t need a distributed and untamperable database. All it needs is incentives tied to objective data). Think about ways to link a variety of collected objective data with contracts and financial transactions in construction — this is a big under-innovated space.

Public performance objectivity — when a restaurant is crappy, the world knows about it. When a contractor is crappy — we don’t. Think about opportunities to publicize performance data.

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Sources:

• Arcadis Global Construction Dispute Report 2019
• Reducing Construction Costs: Uses of Best Dispute Resolution Practices by Project Owners 2017